Question

Note: The following information is common to the two Pwasato Co. questions.

An analyst is in the process of estimating the market value of Pwasato Co. Based on his analysis of the company’s financials, he estimates the company’s free cash flow for the current year to be $90.50 million. Since Pwasato Co. has just launched a well-received product, the analyst believes that the company’s FCFs will increase by 30% per year for the next 3 years. After the third year, he expects the company’s FCF growth rate to decline steadily until it stabilizes at 3% per year 7 years later. The company’s WACC is 16%.

Question: What is the company’s horizon value? Report your answer in millions of dollars to two decimal places. Do not round numbers in intermediate steps.

Question: What is the company’s value of operations? Report your answer in millions of dollars to two decimal places. Do not round numbers in intermediate steps.

Answer 1

Given,

FCF for 2020 = $90.5 million

WACC = 16%

Next 3 year FCF growth = 30%

It is expected that FCF will grow at 30% for the next three years.

FCF for 2021 = FCF for 2020 * (1+30%) = 92.5 * (1+30%) = 117.65

In a similar way remaining FCF for 2021 and 2022 is calculated.

FCF for 2022 = 152.95

FCF for 2023 = 198.83

After the 3rd year, FCF will decline steadily and stable at 3%.

To decline FCF and stabilise at 3% after 7 years, we need to steadily decline the FCF over 7 years

There is total 27% difference between third-year growth rate and final year growth rate, therefore we will divide that difference by 7 years.

= 27%/7 = 3.86%

Hence FCF will decline steadily at 3.86% over the next 7 years.

2024 year growth rate = 30% - 3.86% = 26.14%

and FCF at th year 2024 = FCF at 2023 year * (1+2024 year growth rate) = 198.83 * (1+26.14%) = 250.81

In a similar way remaining FCF from 2025 and 2030 is calculated.

	2024	2025	2026	2027	2028	2029	2030
FCF	250.8	306.7	363.2	416.1	460.7	492.3	507.1

Calculation of Discount Factor = 1/(WACC)^n

WACC = discount rate = 16%

n = no of year

Discount Factor 2021 = 1/(1+16%)^1 = 0.86

Discount Factor 2022 = 1/(1+16%)^2 = 0.74

Calculation of Present Value = FCF * Discount Factor

Present Value 2021 = FCF 2021 * Discount Factor 2021 = 117.65 * 0.86

Present Value 2021 =101.42

In a similar way remaining PV's are calculated and below is the summary table,

Year	2020	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
FCF	90.50	117.65	152.95	198.83	250.81	306.70	363.22	416.15	460.74	492.33	507.10
FCF Growth Rate		30.00%	30.00%	30.00%	26.14%	22.29%	18.43%	14.57%	10.71%	6.86%	3.00%
					3.86%	3.86%	3.86%	3.86%	3.86%	3.86%	3.86%
Discount Factor		0.86	0.74	0.64	0.55	0.48	0.41	0.35	0.31	0.26	0.23
Year		1	2	3	4	5	6	7	8	9	10
PV		101.42	113.66	127.38	138.52	146.02	149.08	147.25	140.54	129.46	114.95

Answer 1) Horizon Value / Terminal Value = FCF 2030 *(1+Terminal Growth rate ) / (WACC - Terminal growth rate)

= 507.1 * (1+3%) / (16%-3%) = 4017.80

Present Value of Horizon Value = FCF year 20230 * Discount factor at 2030 = 4017.8 * 0.23 = 910.77

Answer 2)

Value of operation = Sum of Present Value all the FCF + Present Value of Horizon Vaue

= 101.42+ 113.66+127.38 +138.52 +146.02+149.08+147.25+140.54+129.46+114.95+910.77

Value of operation =$2,219.06

Concluded.